In January 2022, the State Bank of Pakistan (SBP) announced that in line with its objective of financial inclusion and digitising financial transactions it would, in the first cohort, approve five digital banking licenses. Regulatory frameworks for digital banks, also known as neo banks or challenger banks, have been propagated in a handful of countries globally; hence, once again the Pakistani regulator is leading from the front.
The SBP has a history of framing highly successful regulations. In 2001, it created a special license category for microfinance banks — this resulted in 4.65 million active microfinance loan customers and 75.5m saving customers, while our highly profitable commercial industry has only managed 1.5m active loan customers.
The SBP followed this with the Branchless Banking (BB) regulations. This allowed BB operators to convert kiryana (mom and pop) stores to become banking service touchpoints and was indeed revolutionary in bringing financial services to the common man.
The last license introduced was the Electronic Money Institution (EMI). The EMI license allowed non-financial institutions with a material customer base to enter the payments business. Using the customer lens, these EMI, when they are launched commercially, are expected to also digitise cash transactions.
Market information indicates that there are more than 40 local and international applicants vying for the five licenses
The digital banking license announcement by the SBP has created more excitement locally and internationally than all the previous licenses combined. After all, Pakistan is a country ripe for financial inclusion. Currently, it has only 10m active loan customers. While digital payments are growing exponentially, they remain a fraction of cash transactions.
Similarly, while in the recent past, digital wallets have experienced phenomenal growth, active wallets are still under 10m. We have the ability to verify a customer’s identity using real-time biometrics and are moving towards facial and voice recognition. Hence, both the railroad and the addressable market exists for building a game-changing institution.
The SBP has been a visionary in creating the enabling environment for a successful digital bank. It must demonstrate even more sagacity in awarding the digital license. The market information is that there are more than 40 local and international applicants vying for the five licenses. The SBP’s utmost priority should be to increase the number of active loan customers. Its ambition should be 100m loan-active individual and small and medium enterprise (SME) customers over the next five years.
The driver has to be lending, not payments or savings. The reason is that the payments’ objective of the SBP can be achieved through the existing EMI license and does not require a digital banking license. The 100m active loan customers must firstly come from individuals, with additional weightage for rural, female and youth.
This is possible through data-based lending. Artificial intelligence, using data points from smartphones, GSM data, e-commerce purchases, and food deliveries, provides adequate data points to enable small ticket instant loans to this segment. This will entail high loss rates at inception, till the algorithm learns to discern between a good and bad customer. Without this risk-taking, we will remain a low lending penetration country.
Similarly, additional weightage needs to be provided for lending to the ‘s’ of the SMEs and small farmers. The SMEs, especially the small enterprises, have been seriously neglected by the banking section. Like the individual segment, lending must be based on analytics based on data points and not the traditional collateral method.
Data, which has always existed has now been digitised and made readily available. Using data points like purchases from fast-moving consumer goods (FMCG), air time from telcos, receivables and payables from start-ups, and digitised khatas (physical ledgers), a digital bank must make material inroads in this neglected space.
Similarly, digital banks if they truly want to address the needs of the masses must develop innovative savings products. They need to understand how Pakistanis save, and currently putting money in a bank account is not the most popular mode of savings.
A digital bank must have the customer lens as its principal lens. How easy is the customer journey? How friendly is the customer app? How much memory of the phone does it consume? The customer journey cannot be limited to the front end. How long does it take for the digital bank to make a credit decision? This must be in seconds… not days. How quickly are approved funds made available? Again, in minutes… not days. All required documents must be digital and embedded in the app and digital signatures are a must. The customer journey must be frictionless.
The SBP has created a positive enabling environment through digital banking regulations. To meet its principal objective of financial inclusion, it must make the customer journey and digital lending its principal criteria.
The writer is Chairman Pakistan Fintech Network.
Published in Dawn, The Business and Finance Weekly, March 21st, 2022